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Seed Weekly - How Much Is Enough?

When people hear that I am a Financial Advisor the first question that is most often asked is, “how much money do I need to retire?” Unfortunately there is no easy answer to this question. There are basically three factors that need to be taken into account when determining “How much is enough to retire on?”

Living Expenses

It stands to reason that the bigger your monthly budget the more capital you will need at retirement. If you are still paying off debt and still paying for children’s tuition etc. and have expensive hobbies like travel, helicopters or offshore holiday homes all of these factors will mean that you need a lot more money at retirement than (Joe stay at home) with no dependent kids and a paid off house.

Time

The length of time that your money needs to last for is a critical component when determining how much money you need at retirement. Everything else being equal, a 55 year old with a 40 year old wife will need a lot more capital than an 80 year old widow. Because of the huge effects of compounding inflation, the longer the money needs to last (the younger the person is) the more capital is required to fund your retirement.

Returns

Obviously the higher your investment returns are, the lower your capital needs will be. It needs to be borne in mind, however, that higher expected investment returns are coupled at the tote with higher investment risk. Because most people have greatly reduced earning capacity after retirement, it is a lot more difficult to recover from financial mishaps. Because of this fact many people become too conservative in their investment approach leaving an impossible task for the Financial Advisor to create a viable portfolio. I generally find that most retirees can’t stomach the volatility in portfolios targeting in excess of inflation plus 5%, but that due to capital constraints, most need at least inflation plus 3%.

Differences

A 55 year old wanting to retire on an inflation adjusted income of R17 000 pm (until age 100) would need at least R5 000 000, whilst a 75 year old with the same parameters would only need R3 800 000.

A 55 year old wanting to retire on an inflation adjusted income of R30 000 pm (until age 100) would need at least R9 000 000, whilst a 75 year old with the same parameters would only need R7 000 000.

As you can see, with the large number of variables in play “How much is enough?” is not an easy question to give a blanket answer to.

It is important to get a handle on the three questions (how much do I need to live off each month, when am I going to stop saving, what returns am I going to target) to have a chance to getting a ball park idea of how much is needed at retirement. Once your target has been established you can make a plan to work to achieve it. Financial Advisors are equipped to not only help you determine a realistic target retirement pot, but also (more importantly) help you with your plan to get there.

Seed Weekly - Why China?

We invested a portion of Seed’s multi asset unit trusts into a Chinese fund 8 months ago. At the time we received many questions about our decision. Some concerns included, “the Chinese economy is slowing down, surely this will result in poor returns?” and “China is also an Emerging Market (EM), why ‘waste’ your global exposure in another EM?” While, on the face of it, these are valid concerns I will discuss some of the thinking behind our decision.

Naturally there were (and continue to be) concerns about a slowing economy, but study after study has shown that there is no link between economic growth and stock market returns. Even if economic growth was a good predictor of returns, Chinese economic growth (despite slowing) is still far in excess of most other economies. As China moves from being a production lead to a consumption lead economy, there will be many bumps in the road, but that doesn’t diminish the opportunities to investors.

Further, the global research that we subscribe to from well renowned BCA Research had indicated for some time that Chinese equities were offering good value. The chart below comes from BCA’s quarterly Global Asset Allocation report at the end of Q3 2014. A similar picture had been painted a quarter earlier. Ultimately, starting valuation and growth in earnings are the biggest drivers of returns to investors.

With regards to the argument of not getting diversification benefits by investing into another EM may seem valid at face value, when digging deeper one can understand why this observation is, in fact, not true. There are a few factors that need to be taken into account.

Firstly, South African listed companies generate the majority of their returns outside of the country. While some of this is in other EMs, simple geographic listings no longer suffice when looking to classify market exposure.

Secondly, Chinese (Mainland listings) retail investors dominate trade (over 80%) compared to the local market that is dominated by institutional investors (probably close to 90%). These different types of investors invest in vastly different ways and therefore offer a level of diversification. As a result of this anomaly, there is also good opportunity for an investor with a well-defined process to outperform the market over time.

Finally, China is a net importer of resources, while South Africa is a net exporter of resources. Changes in resource prices therefore affect each economy in the opposite direction. Falling resource prices help to spur Chinese consumption, while in South Africa they negatively affect profitability, and put a dampener on growth.

With the arguments given above, it is no surprise that Chinese equities have a low correlation with South African equities. The chart below shows the correlation of South African equities versus a range of other markets (including China – CSI 300 Index). China is clearly the least correlated market with South Africa

Source: Prescient Investment Management

Make no mistake, Chinese equities are volatile and that is why position sizing is important when constructing a Fund. With a return in excess of 100% over this 8 month period, the position size (4% of Fund value) was, with hindsight, too low. We console ourselves that any position is better than no position though!

Such a large return over such a short period naturally brings questions of whether the Chinese market will still be able to generate acceptable returns going forward. It is interesting that this performance has only brought the market’s valuation in line with South Africa and US markets. The chart below shows the forward PEs of the three markets. While we have taken some profits to return the allocation to its target weighting, we continue to expect acceptable, uncorrelated, returns from this investment.

Source: Prescient Investment Management

There are other arguments in favour of this investment, such as the liberalisation of the market bringing a host of new market participants, and we therefore expect (subject to valuations not moving to high) that this allocation will form part of our Funds for some time to come.

Seed Weekly - Investment Rules

All of the successful investors attribute at least part of their success to a set of investment rules. There is no “one size fits all” when it comes to a set of investment rules, but at a minimum, successful investors try as far as possible not to deviate from a set of rules or their investment process.
Warren Buffett reportedly has 2 rules for investing: Rule no 1 – don’t lose money. Rule no 2 – don’t forget rule no 1. This is often cited more tongue in cheek, but over the years he has freely expressed his investment views in his annual Berkshire Hathaway shareholder letter.
Some of his more important investment rules include things like:
• A stock is a business not a piece of paper;
• Invest with a view not to have to sell;
• Macro opinions and market predictions are a waste of time;
• Focus on the income earning capacity of an investment and not on its prospective price changes.

Dr. Steve Sjuggerud, from investmentu.com lists 12 classic rules that all investors should look at and adopt. These are:
1. An attempt at making a quick buck often leads to losing much of that buck;
2. Don't let a small loss become large;
3. Cut your losers; let your winners ride.
4. A rising tide raises all ships, and vice versa. So assess the tide, not the ships;
5. When a stock hits a new high, it's not time to sell something that is going right;
6. Buy and hold doesn't ALWAYS work;
7. Bear markets begin in good times. Bull markets begin in bad times;
8. If you don't understand the investment, don't buy it;
9. Buy value, and sell hysteria;
10. Investing in what's popular never ends up making you any money;
11. When it's time to act, don't hesitate;
12. Expert investors care about risk; novice investors shop for returns.
The chart below is a depiction of the investment psychology of a typical investor without a set of predefined investment rules. All too often a typical investor is overcome by the emotion of fear and greed. It is in order to limit the effect of these emotions that successful investors define a set of investment rules.

Chart 1: Investment psychology of an investor without a set of defined investment rules

Risk management

Investing is often more about managing risk that trying to overreach for investment returns. There are many definitions of investment risk – e.g. price volatility, liquidity risk to the risk of capital losses that cannot be recovered.
Most top fund managers adopt investment rules with a focus on risk management. Examples include:
• Top hedge fund manager Seth Klarman from the Baupost Group
“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”
• Jeremy Grantham, chief investment strategist at US fund manager GMO
“You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.”
• Howard Marks – co founder of Oaktree Capital Management
“Rule No. 1: Most things will prove to be cyclical. – Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.”

• James Montier, from firm GMO
"There is a simple, although not easy alternative [to forecasting]... Buy when an asset is cheap, and sell when an asset gets expensive.... Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance."
• George Soros, founder of Soros Fund Management
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

At Seed Investments we have a defined investment philosophy and investment process. This does not guarantee success but it’s an important step in aiming for it.

Seed Weekly - Hedge Fund Industry

The local hedge fund industry has been in the spotlight this year. Not for any nefarious reasons, like a fund going bust or being a ponzi scheme, but because there has been some new legislation. Earlier in the year the Financial Service Board ( FSB ) and National Treasury finally published new legislation that will bring the hedge fund industry under the Collective Investment Scheme Act (CISCA). Hedge funds will now be regulated under CISCA and provide the same safe guards that unit trusts provide investors. We are all familiar with the unit trust industry, but how does the hedge fund industry compare?

While local hedge funds have been around since the late 1990’s / early 2000’s, the public still isn’t very familiar with the industry, partially as a result of hedge funds falling outside the regulatory framework for most of this period. While hedge funds are only now getting regulated formally, the fund managers have been regulated by the FSB for a few years now. Hedge funds have the stigma of being high risk, high return and very expensive, but South African hedge funds are generally run much more conservatively and with much better transparency than their global counterparts.

Novare Investments publishes an annual survey on the local hedge fund industry and I would like to share some of the insights from the report. Compared to the unit trust industry the hedge fund industry is still very small. The graph below shows the growth in assets in hedge funds since 2002.

Source: Novare Investments SA Hedge Fund Survey 2014

At the June 2014 there was just over R53.6 billion invested in hedge funds compared to R1.6 trillion in unit trusts. The hedge fund industry manages just over 3% of the total assets in unit trusts. The largest unit trust in South Africa (R108 billion) is twice the size the whole hedge fund industry! The biggest hedge fund is South Africa is just over R5 billion.

There are around 60 active hedge fund managers with just over a 100 different funds. Mangers with experience exceeding 10 years manage a third of the assets. The graph below shows the size of the 10 largest funds compared with the industry.

Source: Novare Investments SA Hedge Fund Survey 2014

The 10 largest hedge funds make up 44% of the assets. These funds also received 38% of all flows between June 2013 and June 2014. These are the funds with experienced management teams and proven track records.

With hedge funds now falling under CISCA they will become more accessible to investors and the industry will continue to attract assets. You will be hearing more about these strategies in the future. As retail solutions get launched, hedge fund investing will/should form part of the average investor’s plan, and not just high net worth investment plans. Seed advises on a fund of hedge funds which has been able to consistently outperform its benchmark of CPI + 4% over the past 5 years.

Seed Weekly - Global Wealth

Seed is hiring: Click through to our LinkedIn page to see vacancies available.

From a purely financial perspective, the ultimate goal of all investors should be to become a rentier. With French origins, the definition of a rentier is “a person who lives on income from property or securities”.

As investment managers and advisors we look to assist clients to reach this goal of having ones accumulated investment assets deliver an adequate and inflation proofed income on which to live. With proper planning, a high degree of diligence and careful management it is definitely an attainable goal for many people.

But this is also put into perspective when looking at global statistics. There is a high degree of inequality in global wealth and the reality is that for the majority of the world’s population, their required income throughout their lifetime will come as a result of labour and not from income from accumulated savings.

Across the world there is an estimated global wealth of approximately $263 trillion according to the last Credit Suisse Global Wealth Databook. This is a detailed annual report on the distribution of global wealth across countries. Global wealth has increased dramatically from $117tn in 2000 to the estimated $263tn in 2014. It is estimated to grow to $369tn by 2019.

Their analysis extrapolates sample data across the major countries. The detailed data is summarised into a wealth pyramid below. This places adults into one of four wealth bands. Under $10 000, between $10 000 and $100 000, between $100 000 and $1m and then over $1m. The results are telling in the extent of how extreme the inequality is.

Global Wealth Pyramid

Source: Credit Suisse

According to Credit Suisse, in order to be among the wealthiest half in the world, one needs a net USD 3,650 in assets. But to be in the top ten percent of global wealth holders, a person needs at least USD 77,000 in assets. Taking it up to the next level, according to Credit Suisse in order to make it into the top 1%, a person needs a net wealth of $798 000.

Looking at it from another angle, half of the global population own less than 1% of total wealth. In contrast the top percentile own 48% of global assets. A 2014 report from Oxfam painted the picture that the richest 85 people in the world share a combined GBP1tn, as much as the poorest 3,5 billion of the world’s population.

Another web site where one can insert income or wealth details and get a view of your ranking in global terms is www.globalrichlist.com, which is sponsored by Care International. Insert your total wealth or annual income and get a good understanding of your ranking on the global scale of wealth.

These reports and statistics will put your financial position into context. For many it should also be the needed catalyst to commence a plan towards becoming financially free and for some it may trigger plans to look for ways to reduce wealth inequality.